By Mike McDermott
Traders are reluctantly heading back from the Hamptons after a lazy holiday week of trading.
If you took last week off, you missed a few sessions of light-volume trading. But you also missed a couple of important macro events.
For starters, the Bank of England (BOE), the European Central Bank (ECB) and the People's Bank of China (PBOC) undertook a massive coordinated stimulus thrust before US markets opened on Thursday.
The rate cuts and other stimulus measures should have made significant waves in an otherwise shallow market (due to the 4th of July US holiday). But instead, traders yawned and equity markets actually fell on the day. On Friday, the US jobs report turned out to be a disappointment with only 80,000 new jobs created in June, and the unemployment rate steady at 8.2%.
Traders may not have reacted to the coordinated central bank action, but they certainly got the message from the jobs report. The S&P 500 dropped as much as 1.4% before closing down 0.9%, and the Nasdaq Composite lost 1.3% of its value. The bearish action wasn't just confined to equity markets. Precious metal prices also dropped sharply last week (quite the opposite of what you might expect in light of the coordinated central bank action).
On Friday, Jack laid out the Mass Capitulation Thesis - explaining why gold and silver bulls could end up being disappointed, as the global economy remains stuck in an "ugly Goldilocks scenario" (not to hot - not too cold). The long-term weekly gold chart looks anything but bullish - and could be setting up for a significant break in the near future.
As if the macro picture didn't offer enough uncertainty, this week marks the official start of earnings season. Alcoa Inc. (AA) kicks off the action after the market closes on Monday, and traders will be paying close attention to Google Inc. (GOOG), JPMorgan Chase (JPM) andWells Fargo (WFC) later in the week. There are plenty of catalysts (both technical and fundamental) on the horizon, setting up some interesting trading opportunities for the new quarter.
Below are a few of the areas we are focusing on this week…
Extended Bullish Stocks Vulnerable to Reversal
In today's environment, there are a number of well-liked stocks which have become extended and are now vulnerable to a pullback. We're watching several of these extended names with the intent of capturing short-term gains as stockholders take profits. Sentiment levels have been volatile, and given the bearish macro picture, investors are more likely to begin cutting back on risk and trimming their winning positions.
For these snap-back trades, there are a number of necessary elements that must be in play:
- To begin with, positions must be significantly extended, with plenty of room to decline before hitting support levels. This gives us enough expected value to justify the risk.
- In order to actually enter the trade, price action must move in our favor. We use stop-limit orders to execute each entry, so the trade is only taken when the stock actually begins to retrace.
- Risk points are managed aggressively to quickly cut back on the amount of capital at risk for each trade. Once an extended stock has begun to pull back, any strength is an indication that it is time to exit our short position.
- We also establish a swing target before entering the trade, ensuring that we take profits before the stock hits key support areas.
Ocwen Financial (OCN) is a good example of a name that has moved significantly higher over the last month and could be vulnerable to a pullback. Notice that the stock is not only well above any swing low on the daily chart, but it is also extended above both the 20 and 50 EMA (Exponential Moving Average).
Snap-back retracement trades work especially well in choppy environments where broad equity indices continue to run into resistance, and sector trends are relatively short-lived.
The Mercenary HPSS (High Probability Swing System) has been active on this front, setting up a number of snap-back swing trades while keeping exposure light. Trades are closed relatively quickly (usually in 3-5 trading days) which helps to keep the amount of capital at risk low, while still providing plenty of bullish and bearish opportunities.
Retail Still A Bearish Stock Picker's Playground
With macroeconomic weakness on three continental fronts (Europe, China and the US), global retail companies are hard-pressed to find growth opportunities.
Up to this point, China's growth engine had been strong enough to offset weakness in Europe, and while the US picture wasn't exactly constructive, affluent consumers were strong enough to prop-up the broad retail sector.
But now that China is setting up for a hard landing, and the US employment picture is lagging, the retail sector is looking much more vulnerable. It's interesting to note that companies who cater to affluent consumers are now taking on water. Lululemon Athletica (LULU), the high-priced yoga apparel chain has fallen more than 25% from its peak. Harley Davidson (HOG) is working on a bearish head and shoulders pattern. And Tiffany & Co. (TIF) is in a full-fledged downturn.
Our Mercenary Live Feed still has an outstanding short position in Coach Inc. (COH). This is another upper-class retailer which continues to cut through support levels as traders lose confidence in the sector. Many of these names are trading at valuation levels that support more sustained downtrends - as opposed to short-term pullbacks more suited for swing trading.
Heading into the week, we're still sporting very light exposure levels. The majority of our activity has been centered around short-term swing trades as we wait for more clarity on the macro picture.
Eventually as the macro picture crystallizes we will find opportunities to take larger trend plays. Earnings reports and commentary from key management teams could go far in influencing investor sentiment - providing more long-term direction for broad markets. This week has potential for much more meaningful action, as traders return from the 4th of July holiday week and start reacting to earnings season.
Two hours before the opening bell, S&P futures are modestly red and traders are once again focused on Europe - with Spanish bond yields surging ahead of an important meeting in Brussels.
Trade 'em well this week!
Disclosure: I am short COH. As active traders, authors may have positions long or short in any securities mentioned. Full disclaimer can be found here: http://mercenarytrader.com/legal/